Taxes are always a high-stakes game; we’ve got the players.
The Business Joural asked accountants and consultants to speak to key issues affecting business and personal income taxes in light of federal tax reform, among legal rulings, ongoing technological changes, identity theft, nonprofits, and a new area of interest: opportunity zones.
Their answers below touch on tax-friendly strategies, emerging technologies and investment opportunities, changes facing accounting,
finance and tax departments, and growing sophistication from financial scam artists.
EMERGING
3 New Technologies With the Biggest Impact
Three new technologies could reimagine corporate accounting, finance and tax departments.
Chief executives are thinking a lot about technology—89% of CEOs feel personally responsible for leading technology strategies within their organizations, according to KPMG’s 2019 U.S. CEO Outlook.
In tech-savvy OC, where early adoption is often the norm, that number could be even higher.
Execs also grapple with implementing new approaches and hiring and training people to keep up with the changes.
They know it’s not about whether to invest—but how.
Data and analytics drive innovation in products and services, and within an organization accounting, finance and tax are pushed in new directions as they manage technology investments.
Teams must effectively incorporate data and analytics solutions into departments and determine impact—and benefits—of the disruptive internal moves that can help rewrite the role, and their contributions to the bottom line.
Cloud computing, AI, and blockchain are three frequently discussed technologies predicted to have a great impact on these functions.
Together, these technologies offer on-demand information sharing, automated tasks, the ability to detect potentially risky business transactions, and the identification of regulated transactions and business issues.
Separately or combined, these three mean new questions and new solutions for accounting, finance, and tax.
KPMG surveys show department heads are thinking about these issues—data and analytics, emerging technologies, and other areas. For instance, while 76% of chief tax officers say investment here will see the biggest increase in tax function over the next 12 months, only 45% believe their department is ahead of the curve on innovation—let alone keeping up.
Acknowledging the vital role of increasing speed and efficiency in their departments, they’re grappling with how to bring those benefits to fruition. For many local companies, changes driven by technology will be nothing short of a full rethink.
When the technology is harnessed correctly, it can help manage risk, streamline tasks, free-up professionals’ time, and, ultimately, drive significant value for the organization.
What Happened When I Called Identity Scammers
Every tax season brings something fresh for CPAs—new guidance on reporting income or deductions, or important effects of new legislation and trade policy, for instance.
This year, we saw increasingly sophisticated attempts at identity theft.
Some of our clients received very official looking letters stating they owed tens of thousands of dollars in delinquent taxes. One client brought me a notice they received in the mail from the “Tax Bureau of Orange County.” Untrained eyes see an official but of course—no such organization exists.
It was an elaborate identity theft scam.
I called the number on the notice and said I was a CPA calling on behalf of my client.
The line went dead.
I tried again and a different person answered. This time I pretended I’d received the notice and let them spiel out as much their patter as possible without giving up any sensitive information.
Their approach is clearly to prey on the uninformed with the specter of legal action threatened via official-sounding jargon; I wanted to understand as much of the process as I could to inform others.
When I’d heard enough, I said I was a CPA and would be reporting them to actual authorities.
The line went dead again.
More research unearthed an extensive effort—and the scam was known to authorities, as it had been perpetrated on other OC taxpayers.
In an age of robocalls and email phishing, elaborate letters and telephone efforts are seeing a resurgence; clients over the last several years have alerted me to these illegitimate notes—this year was the worst.
Stress over compliance with new tax guidelines coupled with hearing a real person on the other end of the line can coax the marks to lower their guard; the need for caution has never been greater.
People must be diligent to combat these scams, and not provide any personal information—social security numbers, taxpayer IDs, financial, and so on—or otherwise, even at the threat of prosecution.
Instead, contact the IRS at phishing@irs.gov or report it to the Treasury Inspector General Administration, immediately, as well as local law enforcement agencies.
REGULATORY
Nonprofits Experiencing Big Accounting Changes
The one constant is change.
Recent changes to financial regulations—including the rollout of the Tax Cuts and Jobs Act to GAAP rules that govern revenue recognition and lease accounting—have left even the savviest of CFOs with plenty more questions than answers.
This is particularly true for county nonprofits, facing their first change in financial reporting in 25 years. Financial statements for nonprofits have been restructured to create transparency and comparability with other charities. As nonprofits adapt to new compliance rules, they also seek to solidify partnerships with OC’s robust donor class—a group reviewing philanthropic strategies in light of the higher standard deduction.
To assist nonprofits in implementing these changes, Haskell & White held its annual Nonprofit Conference in April. In a post-event survey, 65% of respondents, including CFOs from the area’s leading charitable enterprises, said they need to learn more about financial matters. Many indicated they’ll seek CPA support or add financial staff.
There’s an additional, possibly larger challenge looming for them: the number of taxpayers who itemize is expected to drop to as low as 5%. If charitable giving lowers in turn, this could mean dramatically different fundraising strategies.
Nonprofits can adapt in many ways. First, they must understand who comprises their audience. With fewer people giving, denser donations from wealthier donors will be more important. Finding them could require new marketing strategies that are more aggressive than what has worked before.
As the compliance landscape and donor behaviors change, nonprofits must adapt with the times to keep up and get ahead—even if it means stepping out of their comfort zones.
State Court Throws Contract Workers Into Upheaval
With the Dynamex decision, the California Supreme Court created new, unlegislated law with respect to the use of independent contractors; many companies continue to seek advice on how to mitigate the impact of that case.
Dynamex, adjudicated in favor of California tax collectors, has implications on the state’s growing gig economy—think Uber and other tech-based services—as well as many multistate enterprises. Both industries rely heavily on independent contractors.
Employers must now evaluate whether to reclassify contractors as employees to avoid significant fines or restructure their organizations to minimize these rules.
For example, if a California-based company employs 150 workers and half aren’t in the state, bifurcation of the non-California activity or business should be evaluated to obtain legal certainty as to classification for those independent contractors.
But Dynamex isn’t the only recent tax-related event—many of which are giving companies reason to seek advice on how to leave California. As the current state legislature continues to discuss new and creative taxes, business owners and CEOs are increasingly evaluating the benefits of moving to a state with lower taxes—or none at all—and fewer regulations.
New state tax proposals seek to tax services (SB 993), create a single-payer healthcare system (SB 562), impose a 10% business tax on net income (Assembly Constitutional Amendment 22), and increase property taxes (split-roll legislation) to name a few. The California Tax Foundation estimates more than $6.2 billion in new taxes and fees are being considered.
Nine states have no or nearly no state income tax: Alaska, Florida, Nevada, New Hampshire, South Dakota, Tennessee, Texas, Washington, and Wyoming.
Accountancies for decades, including RJI CPAs, have helped business owners with tax planning and migrating businesses to other states—before, during, and after a move.
TAXES
Business Owners Consider Fleeing State’s High Taxes
Excessive taxes in California have routinely been viewed by high-income residents simply as the price paid to enjoy the great year-round weather and sandy beaches.
While some consideration has been given in the past toward establishing residency elsewhere, the actual exiting of the state to avoid the onerous tax laws was usually not acted upon.
This view is giving way to business owners aggressively approaching ways to reduce taxes by leaving California permanently. Our firm has had many discussions and performed various analyses in the last few years for clients who ultimately left the state or are seriously considering doing so—soon. The recent cap on state tax deductions under tax reform was the last straw.
Departing California for a state with no income tax, such as Nevada, is a popular choice. This cuts state income tax from a top rate of 13.3% in California to zero—a substantial potential savings. But the strategy doesn’t come easy; companies must meet hurdles for income to no longer be taxed by California.
To avoid this there are two basic rules:
• First, a resident pays California tax on worldwide income.
• Second, California will tax income generated here regardless of where you live.
The latter point can be challenging, if not impossible, for certain businesses considering a move.
The state looks at 29 factors to determine residency, including where most of a person’s time is spent, location of family practitioners—doctors, dentists, and the like—car registration; ownership and occupancy of custom-built homes, voter registration, and church attendance and charitable donations, among other elements.
Even if you meet these factors, the state can still try to claim that the taxpayer has a closer connection to California than any other locale. Residency is ultimately decided by that metric: trying to establish the state with which you have the “closest connection” during a taxable year. This makes it imperative to cut as many ties as possible with California. Needless to say, state government is making it very difficult for people to lose California residency in an environment where leaving is becoming more popular by the day.
Biggest Questions Asked Since 2017 Tax Reform
Eighteen months have elapsed since passage of the most sweeping tax reform since 1984, and many of our clients have lingering questions related to minimizing their tax burden. These include:
• Should my business and I move out of California?
While Californians were heavily affected by federal tax reform, don’t pack up just yet. Individuals can save on taxes by moving out of state, but this requires commitment to truly doing so: changing car and voter registration, obtaining a new driver’s license, new doctors, social clubs, schools, and spending most of one’s time outside of California.
For businesses, the tax savings may not be as significant as imagined, as their income may be apportioned back to California if that is where the customers are located, negating any income tax motivation for moving the business.
• Should I switch my business to a C corp?
The drop in income tax rates on C corporations from 35% to 21% is a significant factor post-tax reform, but other circumstances must be considered before a change.
For instance, there’s a new 20% tax deduction on pass-through entities’ qualified business income, and lower tax brackets for individuals at higher-income thresholds. Most importantly, the company’s short- and long-term goals should be accounted for on reinvestment, distributions, and eventual exit to determine optimal tax structure strategy.
• Should I invest in an Opportunity Zone Fund?
Opportunity Zone investments have heated up, largely due to more clarity in setting up and operating a fund.
The OZ program is a tax deferral and exclusion tool by which a taxpayer can harvest any existing unrealized gains and deploy them on tax-deferred into an investment within a designated area: the Opportunity Zone. If investments are held more than 10 years, appreciation can be excluded from federal tax.
But taxpayers should know the pitfalls, including time requirements, acquisition of qualified assets, construction or improvement of properties and businesses, along with potential delays from local governments’ approval processes.
OZ investments should first be evaluated without considering potential tax benefits; these won’t rectify bad ideas.
OPPORTUNITY
Why Opportunity Zones Are Taxpayer Friendly
The Opportunity Zones program is one of the most taxpayer-friendly recent additions to the U.S. system. But with little explanation and just a few years to take advantage of the program’s 15% taxable gain elimination, investors must be well-informed before this “opportunity” passes them by.
The program is essentially an investment vehicle that allows two main tax benefits:
• deferral of income, and
• exclusion of taxable income
Rather than recognizing taxable capital gains in a given year as income, taxpayers invest in qualified Opportunity Zone funds. Investments are tied to business in government-designated areas—Opportunity Zones—to defer the recognition of income until the investment is sold, or Dec. 31, 2026, whichever comes first. A 15% exclusion of income depends on the holding period of the investment before Dec. 31, 2026: 10% at five years and 15% at seven.
That means investments must be made by the end of this year for the larger exclusion and 2021 for the smaller. An additional exclusion of income from the appreciation of the investment is available if held for at least 10 years.
The 10-year gain exclusion can be big, but the time constraint on the standard exclusions have been a driving force of immediate interest.
Opportunity Zones exist through Orange County, the rest of California and nationwide. Clients have shown some interest in many areas of the U.S.
Another area of interest, especially for real estate, is a more flexible investment requirement: investors only have to commit an amount equal to the capital gain to defer it into a qualified fund and can keep the remaining proceeds—unlike a 1031 exchange where some excess can be taxable.
Investors and taxpayers are eager to take advantage of these benefits and careful consideration and planning will be essential to navigate and comply with program requirements.
Opportunity Zones: Who Profits, When and How?
The new specially designated tax-saving districts—Opportunity Zones—were set up to stimulate economic growth in areas where development has been stagnant. The U.S. Treasury Department last October proposed regulations on how zones would operate. Here’s a rundown:
• What qualifies as an OZ and who has the authority to designate an area?
OZs are low-income census tracts—areas with a poverty rate of 20% or more. Up to 5% of census tracts contiguous to an OZ may also qualify. Governors have already chosen their state’s OZs. In Orange County, 27 areas in cities like Santa Ana and Costa Mesa are designated as a QZ.
• What type of investors qualify?
Individuals, C corps, REITs, partnerships, and other pass-through entities. Investors need to have recognized recent capital gains.
• How do tax savings work?
It involves deferral and partial forgiveness of capital gains tax. Investors with a capital gain of, say, $100,000, have 180 days to decide to invest a portion or all of the gain in an OZ, either directly or through a fund. At that point, any taxes on the gain are deferred until the OZ investment is sold or until 2026.
If investors hold the investment for five years, the original gain is reduced by 10%; if for seven years, by 5% more. That’s up to $15,000, assuming the full $100,000 gain was committed; investments held for 10 years get additional benefits.
n What’s the best hold time?
The longer the better. To fully realize tax benefits, 10 years is best, with fewer, but still significant, advantages in the shorter time frames. For real estate investors, five-, seven- and 10-year hold periods are not uncommon.
• Which industries are most likely to benefit?
Real estate and construction are obvious options; most industries could qualify if at least 70% of tangible property is owned or leased and 50% of gross income is earned in the zone. An added benefit: many OZs are in emerging urban markets or near universities. These areas attract tech and life science startups, as well as service companies.
No tax benefit makes a bad investment good, but it can make a good investment great. If a fund, PE or otherwise, can invest in an OZ, it can provide a significant increase in returns, whether investments last five, seven or 10 years.
